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REINVENTING RETAIL
The challenge of demand chain innovation
For the past decade, supply chain management has been the mantra of successful retailers. Continuous supply chain improvements have reduced costs, expanded market share, and driven industry consolidation. But what comes next? What happens when supply chain efficiency has squeezed every last dime, drachma, centime and pence out of the global supply chain? Without cost reduction and market consolidation, retailers will have to look to some combination of organic revenue and margin growth to raise profits. To accomplish that task, they will have to turn to demand chain innovation. This Deloitte Research Viewpoint looks into the both past and future demand chain innovations to provide retailers with a road map to this very different future.
CONTENTS
Reinventing Retail ...............................................................................................................1 Speed Kills ..........................................................................................................................2 Supply Chain Innovation ......................................................................................................4 Demand Chain Innovation....................................................................................................5 The Future of Demand Chain Innovations ..............................................................................6 Short Attention Span Retailing .............................................................................................7 Antagonistic Cooperation: Consolidating Services Around a Customer .................................... 8 Strategic Pricing ..................................................................................................................9 Conclusions, Observations and Questions ............................................................................ 11 About Deloitte Research ..................................................................................................... 12 About Deloitte Consulting and Deloitte & Touche.................................................................. 13
Much of the retail innovation in the past has come through steady improvements in the supply chain. By pushing costs down, retailers gained a price advantage that they used to expand market share. Today, we face evidence that the easy improvements in supply chain innovation have, for the most part, been achieved. Retailers will have to look to the demand chain to find the kinds of innovations that will be needed to sustain them into the future.
Why has retail reinvention become so critical in todays marketplace? Because all strategies eventually fail. No matter how successful a strategy may have been in the past, there comes a point in time when the business fails to adapt to a critical change in its competitive environment, and it fails. In many ways, past success makes the process of reinvention all the more difficult. It does not take much managerial complacency, in the face of accelerating change, to produce a failing business where a successful one stood before. It is the speed of business failure, compressing the lifecycle of all retail innovations, that makes the current business situation so different from the past. The original department stores were great family businesses that started in downtown business districts after the Civil War. They were great mercantile emporiums that sought to be all things to all people. Bearing the founding familys name, the ownership and management of these institutions was passed from generation to generation. From their origins to maturity, department stores have endured for more than 100 years. That maturity has been marked by industry consolidation and bankruptcy. The hundreds of department store businesses at the peak of the department store lifecycle have been reduced to but a handful today.
REINVENTING RETAIL
Speed Kills
Faster, faster, until the thrill of speed overcomes the fear of death
Hunter S. Thompson
Changing organizational and competitive dynamics have accelerated the speed by which retail innovations move through their lifecycle. From a market perspective, the success of any concept attracts imitators. At the same time, the number of core consumers and the number of potential real estate locations limits the size of the market. As both the original innovator and its imitators grow, the market becomes saturated. In order to continue
Retail strategies are created, they expand, they reach maturity and then they decline, in accordance with the dynamics of the retail lifecycle. At each stage of that lifecycle, the pace of growth and profitability is different, as are the criteria for success. Competitive challenges change over the lifecycle, as do customer expectations. As a firm ages, the demands on management change. What is critical in the early stages of development can be irrelevant when the business has matured. Some businesses are good for just a brief moment. Others are good for a year. Still others seem like the Eveready Bunny and go on and on forever. The longevity of any retail business is closely tied to the ability of the firms leadership to manage the process of innovation as the business moves through the retail lifecycle. While the department stores took more than 100 years to
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to grow, the appeal of the concept has to be broadened to a larger group. As the appeal broadens, the concept begins to lose focus and the appeal to the original core customer group diminishes. Loss of market share is the clearest quantifiable measure that a retail concept has reached maturity.
reach maturity, warehouse clubs reached maturity in less than 10. Conceived in the early 1980s, dozens of companies scrambled in a land rush to establish, site, open and then operate warehouse clubs. By the early 1990s, only three warehouse club businesses were left standing. The rest either failed or were consolidated into the surviving three. More recently, the original e-retail businesses drove through their lifecycle, going from innovation to growth, maturity and decline in less than five years. Quite clearly, the longevity of any new retail innovation has been compressed.
Signs of Maturity
From an organizational perspective, maturity begins to creep into a retail concept as part of the natural process of growth. As a business grows it becomes more complex. In order to deal with that complexity, management has to build a bureaucratic infrastructure. That infrastructure separates, and in many cases drives out the original entrepreneurial management. Innovation, which was the key to the success of the new concept, becomes harder to generate and maturity sets in. What separates the survivors from the rest? Execution is part of it. But good execution in a business that is in the decline phase of its lifecycle wont get it back into a growth mode. Knowing where you are in the lifecycle, and managing the business accordingly is
also important. However, long-term sustained growth that spans decades requires innovation. While all strategies are destined to fail, the longevity of a business depends largely on its ability to innovate its way back to the beginning of the retail lifecycle. At the heart of retail reinvention is the process of innovation. Innovation can be defined as a process through which knowledge is translated into new products, new services, or an increase in productivity through new operational methods. In the 1950s, department stores got a new lease on life when they began to shift their base of operations from downtown business districts to suburban regional malls. Discount department stores got a second wind in the 1990s when they added groceries to their general merchandise offer.
Over the past thirty years, the focus of most retail innovation has been on improving supply chain efficiency. These innovations have been largely operational in their focus and have come from either changes in technology or changes in format.
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scanning and sought to transform it into knowledge about consumer preferences. From category management, to partnership marketing; from efficient consumer response to collaborative planning forecasting and replenishment, the goal has been to create value by reducing costs, as reflected in inventory levels and mix, new product developments, pricing and promotion.The continued reduction in costs produced what many retailers hoped would be a never-ending productivity loop. Lower costs led to lower prices, which in turn led to greater sales and expanding market share. The weak link in the productivity loop model is its dependence on expanding market share. At some point in time, retailers consolidate their competitive market segment and run out of market share to take.
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16 1980 1985 1990 1995 2000 SOURCE: DELOITTE RESEARCH AND PUBLIC FINANCIAL STATEMENTS
bankruptcies in the 1990s. While not benefiting all retailers, the drop in costs and profitability does show up in a drop in prices for consumers.
New Formats
The other way in which retailers innovated over the past thirty years was to create new formats that in many cases facilitated the process of supply chain improvement. Each new format redefined the retail competitive environment and put the innovator at the beginning of the retail lifecycle.
From discounters to warehouse clubs, to category killers to hypermarkets, each innovation sought to collapse the supply chain in some way, so as to under price the cost structure of the previous retail innovation. Each new innovation created a productivity loop of its own that allowed the innovator to reduce costs, cut prices, and expand market share. While the productivity loop works for the individual retailer, when it is applied to the entire industry, the drive to lower costs becomes, over time, a zero sum game with only the consumer the winner. The productivity loop in its current form works for the individual retailer as long as there are similar, less efficient competitors from whom market share can be taken. The oligopolistic structure of retailing today limits the future application of the productivity loop. As a result, the industry leaders will be forced to look for new sources of innovation.
When checkout was done on a departmental basis, inventory was managed on a departmental basis. The department manager could see when certain SKUs were hot sellers and which ones were not, and adjust the flow of inventory into the department accordingly. With a shift to storewide checkout, departmental level inventory detail was lost. While overall inventory levels were rising modestly, the mix of inventory
While there has been a steady pattern of success in achieving supply chain innovations, efforts at customer focused or demand chain innovation have been fewer, with a significant number of failures along the way.
in the stores was all wrong. The drain on working capital very quickly drove the company into bankruptcy.
W.T. GRANT
One of the early bankruptcies that caught both the retail and the financial industries by surprise was the 1975 bankruptcy of W.T. Grant. An early discount store pioneer, W. T. Grant was in many ways the Wal*Mart of its day. A darling of Wall Street, in the late 1960s, W. T. Grant was a top retail pick of virtually every Wall Street firm. By the late-1970s, the firm was gone, killed by a failed innovation aimed at improving customer service. In the late 1960s, the firm made a commitment to shift from a department-by-department checkout to a storewide checkout at the front of the store. The payoff to this shift would reduce the cost of customer service and improve the speed of the customer through the store, a win-win for both customer and company. After a brief testing period, the new business process was rolled out to all 1073 company stores. Front of the store checkout from the start was a great success with the customer, until it drove the company into bankruptcy. As it turned out, the more successful W. T. Grant was at implementing their new business processes, the faster they moved towards bankruptcy. The problem with front of the store check out is that it required a far more sophisticated inventory management system than what W.T. Grant had.
simple and compelling in its appeal. Build products unique to each customer. Nothing could be more customer-driven or consumer-centric than mass customization. And yet, despite this strong orientation towards the customer, the results of efforts at mass customization have been disappointing. Companies both large and small have tried to tackle the mass customization problem with surprising little success. From Levis custom jeans stores to Gateways promise to build one for you, companies have learned that the cost of mass customization rarely exceeds the added value of the customized product in the eyes of the customer. In the late 1980s and early 1990s, Toyota spent billions of dollars perfecting a customized assembly line. The result was greater complexity, higher costs and more defects. At the end of the day, all customers wanted was a high quality, low maintenance car at a good price. Rarely is there enough difference in a customized product to make a difference to the customer, even with products as complex as automobiles or computers.
HOME DELIVERY:
soared to a peak of $16.8 billion before shrinking to zero, a loss that represents roughly 30% of Bill Gates net worth. Webvan, Kozmo and UrbanFetch failed, in large part, because they could not find enough households willing to pay for a world-class customized delivery service. At the end of the day, no one delivers for less, than the customer. Like many of the early participants in the Internet, the founders of Webvan, Kozmo and UrbanFetch thought they were on the leading edge of a process of creative destructive. They saw themselves as a new channel of distribution, undermining traditional retailers in much the same way as innovations had done in the past. What they really represented was a process of creative failure. Never had more effort gone into the discovery of new and more creative ways of losing money.
Short attention span consumers are not willing to wade through 120,000 square feet of merchandise in hopes of finding what they want. They want it now. In many ways, Federal Express is as much at fault for this growth of impatience as anyone. Fed Ex was the first to pander to the need for instant gratification by promising to get it there when it absolutely positively had to be there. When that promise was first made, it was the exception that was limited to package delivery. Now its the expectation that applies to everything. We love the adrenaline rush that comes from speed. But at the same time we have gotten used to over-stimulation. Like any drug, adrenalines effects wane with overuse. The dosage we need to get the same effect is higher. As a result, the hurdle of speed is only going to get higher with the passage of time.The added speed of delivery is a killer of traditional businesses and traditional ways of doing things. The new stores being tested today can best be described as retailing on at least two cups of espresso. It means putting the consumer in an environment where they are always within an arms reach of desire, but with the desire constantly changing. The store design objective is to simply overwhelm the consumers sense of sight, sound, taste, touch and smell, preferably all at the same time. There are a number of retailers who are meeting this challenge. Going to Virgin Records is like going to a large, high tech block
party. Rock videos and old movies play on large screens. Music is playing everywhere, technologically localized by a sound system that plays rap in the rap music section, jazz in the jazz section. The classical music section has its own specially walled off area where its mostly older clientele has a lower stim, more sedate environment in which to shop. Older consumers, who grew up in the pre-internet era, and there still are a few of us old codger around, have a lower tolerance for over-stimulation.
Sephora also meets these criteria. Walk into the store and you are overwhelmed by colors, smells, and an intense flurry of constant activity. Like Virgin, Sephora is a big box retailer, but one that is winning, not on the depth of its merchandise but on the stimulation of its presentation. Colette in Paris, and the DKNY store in New York are also highstim, short attention span retailers. Colette is on three floors, with 10k square feet, at most. It is the anti-big box retailer. It is like a Noahs Ark of retailing. They have enormous breadth but no depth. The merchandise mix includes mens and womens apparel, house wares, consumer electronics, books and stationary. All of it is presented in a very high-stim environment. There is a cafe in the basement that has soft music and indirect light, for those who suffer from stimulation overload.
The airlines started it. Both United and American tried to have their own reservation systems. The cost was great and the results were disappointing. They eventually created a reservation network that includes other airlines, rental car agencies and hotels. They were better off with an open network than they were with their closed proprietary networks. What they created by giving up control is a shared network that is customer-driven. The more suppliers on the system, the more attractive it is to their mutually shared customers. Credit card companies and banks have moved heavily into a similar type of arrangement. With a Plus System or Cirrus-based bank ATM card, you can get cash in any currency just about anywhere in the world. The arrangement benefits all participants
in the network, producing a higher level of value and lower unit cost as more banks join the network. Network co-evolution is the next step for retailing. By giving away exclusive control of a competitive advantage, retailers can make their offer of more value to the consumer. Walgreen has done it. After developing a prescription network several years ago, Walgreen had difficulty getting physicians to use it. Most did not want to lock their patients into a single prescription provider. Walgreen eventually opened up the network to competitors, losing control of the network but dramatically increasing its value and use by consumers. Walgreens now gets substantially more business from its open, competitive network than it ever got when its network was closed and exclusive.
PetsMart is taking this concept to a new level. By aggregating complimentary pet services under a single roof, they are redefining their business. They are not just selling pet-related items. They are rolling up a complementary set of fragmented services that facilitate pet ownership. These include kenneling, veterinarian services and grooming. In many ways, Kinkos has done the same thing by providing a complementary set of back-office services, all in a single location. Home Depots Expo is another example of aggregating complementary home decorating and remodeling services around the customer. Expo does not sell just home decorating and remodeling products.They also provide a broad set of services that enable the customer to plan, design, subcontract, and complete the project. Ironically, most of the now failed consumer-oriented Internet companies were, at their core, consumer- centric businesses. Like the other examples cited here, they were organized around the consumer.Their failure was due to many different factors, but their strong orientation towards the consumer was not one of them. Similar kinds of business aggregations that would include a retail dimension could be developed around health care, financial services or even mobility. One company could provide the car, insurance, maintenance, even gasoline. And why would it have to be just one car. You may want something with good gas mileage for your commute to work, an SUV for the summer vacation and a nifty sports car for that weekend drive in the country. No one really wants to own all of these cars, all you really want is access.
Pricing takes on a whole new dimension in a consumer-centric world. In a product-centric world, one price fits all. Pricing is used as a means of managing inventories. When inventories get too high, prices are cut; when inventories are too lean, prices are held. In a consumer-centric world, price is a strategic weapon. In an ideal consumer-centric world, every customer will pay a different price. The airlines have understood the importance of strategic pricing for years. The airlines dont compete on customer service, comfort, or high-quality food service. They compete on price. They have avoided product commoditization by having intimate, detailed, real-time knowledge about customer demand and competitive pricing. They price every seat in their inventory accordingly. Following the airlines, many retailers will begin to charge consumers different prices for the same product depending on their knowledge of the consumers shopping habits. Not all consumers are the same. And not all of them want a particular product or service with the same intensity or at the same point in time in the products lifecycle. Learning to discriminate on the basis of price will be one way that retailers bring their knowledge of the consumer to bear. Discrimination can be done by channel, by time, by product or service mix, by region, by specific store location, or even by season. Price discrimination is becoming rampant on the Internet, as customer purchase behavior becomes better understood.
Strategic Pricing
Price Management
More effective price management represents an enormous opportunity for driving improvement in retail profitability. There are two primary approaches to price management: price optimization and markdown optimization. The goal of price optimization is to set the right price from the outset to optimize the price/volume tradeoff and maximize profitability, either through a set of business rules or analytical techniques. Price optimization applications can produce value across a broad spectrum of retail products. They have particular value when applied to products like food, staples, and non-seasonal items, that have either a short shelf life or more certain demand patterns. Retailers offering SKU-intensive assortments or having multiple stores will derive benefits from pricing optimization. The complexity of price optimization lends itself to an analytical approach that takes a wide variety of different variables into account, including varying demand by store, competitor pricing, a retailers long-term price positioning, sales and margin objectives, and consumers sensitivity to changes in price. Price management solutions can also help retailers in establishing pricing for private label programs in relation to the
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Markdown Optimization
The goal of markdown optimization is to extract the maximum gross margin dollars from a product over the course of a season or the products life cycle, by taking merchandising constraints, category goals, and sales trends into account. Markdown optimization is appealing for promotional, fashion-oriented, or seasonal products. Markdown optimization seeks to balance pricing with inventory levels on a store-by-store, category-bycategory basis. The optimization application continues to refine its forecasts based on current sales patterns, and will enable maximization of gross margin dollars. Price and markdown optimization take on added importance in a retail world that will be dominated by price deflation. A deflationary cycle has taken hold in a growing number of product categories, from apparel to consumer electronics, from autos to home furnishings. Very few managers in the retail business today have ever operated in a deflationary environment. In past downturns, a decline in the real volume of business was masked, in part, by rising inflation. A company may have sold fewer units, but the dollar volume of sales still rose. Inflation masked many of the problems of the business. It meant that even though the business probably had too much inventory, given the level of customer demand, the value of inventory was rising. Inflation also created a buy now mentality on the part of consumers wanting to avoid higher prices later on. In a deflationary environment, falling prices accentuate the decline in business volume, making the problems of the downturn more severe. Just as inflation creates a buy now mentality among consumers that adds to the inflationary cycle, deflation creates a sell now mentality on the part of business in order to sell more product to make up for the decline in price.
comparable branded items at a store, region, or on the national level. The software solution can recommend pricing options versus leading brands in the region, or even the specific store, depending on what pricing strategy is being utilized.
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Tel: 212.492.3951 e-mail: csteidtmann@dc.com As chief economist for Deloitte Research, Carl Steidtmann is a writer, lecturer, and consultant on a wide range of issues including technology, culture, and economics. He has been a student, a teacher, a systems engineer, a management consultant, and a Wall Street economist. His research has been quoted extensively in the Wall Street Journal, The New York Times, Business Week and USA Today. He was on the 10-year plan at the University of Colorado where he earned four different degrees in three different subjects: history, statistics and economics.
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